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How to Invest in Stocks When Interest Rates are Hiked

Wondering how to invest in stocks when interest rates are hiked again? The fact that we know it’s coming is why you shouldn’t worry.

Fears of another interest rate hike are bubbling to the surface on Wall Street once again. People, including our readers, are wondering how to invest in stocks if Janet Yellen gives the short-term federal funds rate another gentle nudge.

Today, I’ll try to answer that question in as much detail as possible. But first, I want to talk about opioids …

What Gets Measured

I have a brother-in-law and sister-in-law who are both doctors. They’re a great source of free medical advice—in fact, I think every extended family should have a couple of doctors.

And sometimes they’re useful when it comes to understanding the business and politics behind medical issues in the U.S. as well.

For example, I recently asked them if they had any insight into the roots of the current epidemic of opioid abuse in the U.S.

What was it that led doctors to begin prescribing more opioids?

And they answered that the culprit was this:

Called the Wong-Baker Faces Pain Rating Scale, it was developed in the mid-1980s by Dr. Donna Wong and Connie Baker, who were seeking a way to enable young children to communicate the level of their pain.

And it worked. Furthermore, its use expanded, first to older children, then to adults who didn’t speak English well, and then to the general populace.

But then, its use expanded too far. Instead of being a communication tool, it became a goal-setting tool—the goal, of course, being to get to level zero, where there was no pain. And the best way to do that was with opioids!

Of course, there were other factors behind the opioid abuse epidemic, not least the drug company that developed and—above all—promoted OxyContin.

That company is Purdue Pharma, and it was Purdue’s formulation of extended-release oxycodone in 1996 (a formulation that was marketed as abuse-resistant because of the time-release factor) that kicked off the boom in oxycodone prescriptions. Abusers quickly found they could bypass the time-release component by crushing, chewing and snorting the drug, and by 2000 the epidemic was in full swing. Seven years later, Purdue was convicted of violating the False Claims Act and paid a fine of $600 million, and today the epidemic is slowly ebbing.

The point is, what gets measured is what people pay attention to.

In the case of opioids, it was the measurement of pain.

In business, everyone knows you need to measure revenues and costs and margins to ensure that a business succeeds.

But what about investing? What should be measured to ensure that your investments succeed?

Well, a lot of people these days are fixated on interest rates, and how to invest in stocks when the rates are hiked.

It’s why every pronouncement by Janet Yellen makes headlines, as investors wait, and wait, for the Fed to raise rates.

In fact, just last week I received the following from a reader.

Tim,

I’m a new investor and would really like to understand what the effect of a rate hike is exactly. This is what I know (or think I know):

1) Shows the economy is strong.

2) Strengthens the dollar and decreases the value of commodities.

3) Makes our products in other countries cost more due to the stronger dollar.

4) Higher cost in other countries means the probable decrease of sales in other countries.

Is this why the stock market doesn’t like the idea of a rate hike even though it clearly shows us that the economy is strong?

Chris W.

Ridgecrest, California

The Coming Interest Rate Hike

Chris’s four points are correct, and his conclusion is generally correct, too. Theoretically, that’s how a rate hike is presumed to affect the economy and the market.

However, some important questions need to be asked.

Q. Has anyone actually proven that interest rate hikes are bad for investors?

A. Yes, there’s an old rule, developed decades ago when interest rate movements were far more common, titled “Three Jumps and a Stumble,” which says that in general, it’s the third interest rate hike that most commonly precipitates a market downturn. After the first two rate hikes, the market tends to keep climbing because business is expanding.

Q. Is it possible that in the current rock-bottom interest rate environment, the relationship between interest rate hikes and stocks will work differently?

Yes, and that’s one reason (along with slow economic growth and low rates in most of the developed world and a lack of inflation) that the Fed has been reluctant to do anything.

Q. Are there other factors that are more relevant to my investing success than the Fed’s interest rate policy?

A. Absolutely. They include the actual trend of the stock market, the actual trend of your own stocks, your system of stock selection and your own portfolio management skills.

Those factors that you can control are far more important to your investing success than the factors you can’t control—like the timing of a rate hike, and how to invest in stocks when it happens.

Q. Is it possible that the coming interest rate hike will be a non-event?

A. Certainly. Whether the rate hike happens or not, the prospect of it has been so thoroughly discussed by all the experts that its effect has already been discounted by the market.

Which brings me to one of my strongest convictions when it comes to the market.

Whatever everyone is most worried about is not the thing you should worry about.

Remember, the stock market is a reflection of all the intelligence of all concerned investors about every factor relevant to investing.

Or, to put it simply, the market knows all.

There’s always something for investors to worry about, but time and time again we have seen that when the market does fall apart, it’s because of an unexpected problem. The expected ones, like Fed rate hikes or the implementation of Obamacare, get discounted and cause no trouble.

In the meantime, the market has given us a great bull market this year, interrupted by a one-month correction that ended last week, and making money in this market is not particularly difficult, provided that you’re focused on what matters.

Since (almost) everyone is thinking about interest rate hikes, the market in fact has already discounted this development—and thus you shouldn’t worry about it!

You shouldn’t focus on how to invest in stocks differently every time the Fed opens its mouth. Instead, you should focus on owning great stocks.

So what might you own today?

How about a stock that benefits from our government’s increasing concern about terrorism, and that’s going up as more and more investors discover it?

One Great Antiterrorism Stock

Bioterrorism and biowarfare are the threats that drive Emergent BioSolutions’ (EBS) business. Its number-one product (accounting for 82% of revenues) is BioThrax, an anthrax vaccine, and its number one customer—by a long shot—is the U.S. Center for Disease Control (CDC).

The company’s current BioThrax procurement contract with the CDC is scheduled to expire on September 30, and there’s no follow-on contract in place yet. But the CDC has reaffirmed its intent to award a new contract, and the stock’s chart (which knows all) says that investors are not worried about that.

As to the company’s other efforts, a big one is the upcoming spinoff of Aptevo Therapeutics, which is focused on cancer research and treatments. The cancer business accounted for 11% of revenues, but a much bigger payout may be in the cards when the spinoff is completed—possibly this summer.

The company’s other two efforts, still small but with strong niche potential, are Emergard, which is a military-grade auto-injector device that has been selected by the U.S. Department of Defense as a platform for nerve agent antidote delivery, and Reactive Skin Decontamination Lotion (RSDL) for removal and neutralization of chemical warfare agents, which has been approved in Israel.

Quarter-to-quarter trends here are not smooth, due to the ebbs and surges in the U.S. government’s buying. Still, the company’s first-quarter results, released May 5, were impressive. Revenues jumped 74% to $111 million, and earnings were $0.16 a share, up from a loss of $0.50 a year ago. If you can survive the stock’s volatility, the long term is bright.

EBS came public in 2006 and has been trending higher since, but there have been three pullbacks of greater than 50% in that time, so this is not a stock for the faint-hearted. Still, the volatility seems to be abating; the latest big pullback, which occupied most of 2014, took the stock down “only” 32%. Most recently, the May 5 earnings report kicked off an advance that took the stock above its old high of 41, so that resistance should now act as support.

If you’re game, you could buy here. A smarter choice, though, would be to become a regular reader of Mike Cintolo’s Cabot Top Ten Trader, where you’ll get 10 recommendations of some of the market’s premier growth stocks every Monday.

To learn more, click here.

Timothy Lutts is Chairman and Chief Investment Strategist of Cabot Wealth Network, leading a dedicated team of professionals who serve individual investors with high-quality investment advice based on time-tested Cabot systems.